Goldman’s real estate gambit

In late 2006, Goldman shrewdly began backing away from the residential mortgage market. With little fanfare, the firm began aggressively hedging its exposure to home loans, in particular mortgages to borrowers with shaky credit histories.

This savvy and somewhat stealthy strategy enabled Goldman to pawn off lots of its soon-to-be toxic mortgages and mortgage-backed securities on other institutions — forcing those foolhardy speculators to pay the price when the subprime market blew up.

And much to everyone else’s chagrin, Goldman even made money off the housing meltdown when some of its hedges — specifically a bet that a subprime mortgage index would plunge — paid off handsomely.

It appears Goldman is following a similar script with U.S. commercial real estate, the next big asset class that many believe is on the verge of disaster.

Goldman recently reported owning $6.4 billion in commercial mortgage loans. It also is holding some $1.6 billion in commercial mortgage-backed securities, or CMBS. That’s a big retreat from where it was just two years ago.

And in a sure sign that Goldman expects a good number of commercial real estate borrowers to default, the firm says it marked down the overall value of its commercial mortgages portfolio by nearly 50 percent.

By contrast, regional banks, many of which have disproportionately high exposures to commercial real estate, are being far less aggressive than Goldman in marking down their respective portfolios.

But Goldman, with a $950 billion balance sheet, can afford to take the lead in marking down loans and indirectly putting pressure on other lenders to follow suit, because its overall exposure to commercial mortgages is relatively light.

Goldman used to have a rather large footprint in the commercial real estate market, with some $16.27 billion in loans and $2.75 billion in CMBS on its books in late 2007. That year, Goldman ranked seventh in bundling commercial mortgages into securities, churning out $15.1 billion in so-called CMBS, according to Thomson Reuters.

By the end of 2008, Goldman managed to whittle its total commercial mortgage portfolio down to a less imposing $10.9 billion.

Goldman says in a regulatory filing that it was able to rid itself of a good deal of its “long positions” in commercial mortgages and CMBS through “dispositions,” or sales of mortgages to other institutions and investors.

No doubt, Goldman also bundled some of it commercial mortgages into the nine CMBS deals it brought to market in 2007.

To be sure, Goldman has taken more hits on commercial mortgages than it did with residential real estate. The firm has taken at least $3.5 billion in write-downs. But Goldman has been able to easily absorb those losses by posting strong trading gains in bonds, stocks and commodities.

And there’s the possibility that Goldman’s strategy for hedging its remaining exposure to commercial real estate could pay dividends if the market collapses. Just as it did with residential real estate, Goldman says in regulatory filings that it relies on “cash instruments as well as derivatives” to reduce some of the firm’s commercial mortgage exposure.

It should come as no surprise that Goldman won’t talk about its hedging strategy. So there’s no way to determine whether Goldman traders are betting that an index that serves as a derivative trade on the CMBS market will plunge, just as the one that tracked the subprime-backed securities market did.

So far, the main Markit indexes for tracking the performance of the highest-rated CMBS are off just 10 to 13 points from their respective par values. By comparison, the most widely followed Markit index for tracking the performance of subprime-backed debt dropped by more than 80 points at its nadir.

Right now, the odds of subprime-like collapse in CMBS valuations appear long and that’s not good news for anyone selling the index short. But further declines would appear likely given the deep haircut Goldman has taken on its own portfolio of commercial mortgages.

No matter what, it would appear Goldman is in a better position than most banks to weather a further slide in the commercial mortgage market. It could even benefit if the market improves and Goldman gets to write up the value of some of the mortgages it’s marked down.